The Investment Returns of Nonprofit Organizations, Part I

• Author: Garth Heutel,Richard Zeckhauser
• Published date: 01 September 2014
• DOI: http://doi.org/10.1002/nml.21100
• Date: 01 September 2014

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N M  L, vol. 25, no. 1, Fall 2014 © 2014 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.21100

Journal sponsored by the Jack, Joseph and Morton Mandel School of Applied Social Sciences, Case Western Reserve University.

Correspondence to: Richard Zeckhauser, Harvard Kennedy School, 79 JFK Street, Cambridge, MA 02138.

E-mail: richard_zeckhauser@harvard.edu

 e Investment Returns of Nonprofi t

Organizations, Part I

TALES FROM 990 FORMS

Garth Heutel1, Richard Zeckhauser2

1Georgia State University and NBER, 2 Harvard Kennedy School and NBER

Nonprofit charities and foundations hold endowments and many other kinds of invest-

ments. How do these investments perform? Some high-profile nonprofit endowments,

including those of colleges and universities, have been studied previously. This study is the

first, to our knowledge, that looks at a large number of the diverse types of nonprofits. We

investigate the determinants of investment performance using a large panel data set culled

from the 990 forms that nonprofits must file annually with the IRS. In this first part of

our article, we discuss our approach and the challenges of using these data to infer invest-

ment returns. The IRS data, though less than perfect, yield valuable measures of the invest-

ment returns of nonprofits. They reveal that some charities consistently do better in their

investment returns than do others.

Keywords: endowment, investment returns, public charity, private foundation

NONPROFIT ORGANIZATIONS, including public charities and private foundations, are

granted special tax-exempt status by the federal government to encourage their work promot-

ing the public interest. Nonprofi ts range widely in size, from small local organizations with

no paid employees to large nationwide organizations that employ thousands. Nonprofi ts also

vary in the ways they secure revenues.  ose revenues have four major components: private

donations, government grants, program service revenue, and investment returns on fi nancial

assets.

We focus on investment returns, a source of revenue that is important for many nonprofi ts,

but hardly all. For the one hundred public charities with the largest endowments, the median

ratio of endowment to expenditures was 7.50. A parallel calculation for those with the larg-

est levels of expenditure in 2007 gives a median ratio of only 0.755, just one-tenth as high.

 is disparity is to be expected, because the fi rst selected on endowment size, and the second

We thank the National Center for Charitable Statistics for data, and Guan Yang, seminar participants at UNCG

and UWM, the editor, two anonymous referees, and various colleagues, for helpful comments. Garth Heutel thanks

the Kernan Brothers Fellowship at the Harvard University Center for the Environment for funding.

42 HEUTEL, ZECKHAUSER

Nonprofi t Management & Leadership DOI: 10.1002/nml

on expenditure, but the salient lesson is that charities diff er dramatically in their reliance on

endowments.

 e largest endowments tend to belong to large private universities and private grant-making

foundations.  e largest endowment among all charities in 2007 was $42 billion; the twenti-

eth-largest was $7.84 billion. When an organization’s endowment is large, whether absolutely

or relative to its expenditures, its rate of investment return is critical. Fortunately, the larg-

est endowments, as has been suspected, appear to secure superior investment returns on a

forward-looking basis.  is happy picture, however, fails to carry over to many other types of

charitable organizations, which on average achieve substantially lower investment returns for

their benefi ciaries, their employees, and their donors than should be possible.  is analysis

seeks to determine how well endowments perform. Its companion article assesses the factors

that aff ect the fi nancial performance of US nonprofi ts’ investments.

 ese articles were completed in February 2013. Concerns with the fi nancial meltdown of

2008–09 have receded, and both the stock and bond markets have recovered strongly. In

the meltdown period, press reports indicated that many nonprofi t endowments suff ered sig-

nifi cantly, including many that had been highly successful in the past. Nonsystematic data

indicate that some are still suff ering in the aftermath. Unfortunately, our data source extends

only through 2007, and data on nonprofi t performance during the period starting with the

2008 fi nancial plunge is not yet available.

A number of articles have investigated the investment performance and portfolio man-

agement strategies of specific classes of nonprofits using survey data based on a subset of

organizations of a specific type. Higher education institutions—many blessed with large

endowments—have received the most study.  e National Association of College and Uni-

versity Business Offi cers (NACUBO) and the Commonfund Institute annually release a study

of endowments, documenting the performance of endowments of higher education institu-

tions.  e data for these studies were obtained from surveys given to endowment managers;

the fi scal year 2011 study included data from 823 institutions.  e Commonfund Institute

also releases annual reports on investment performance for nonprofi ts in various categories,

including health care, private foundations, and operating charities. Its 2011 foundations

report includes data from 175 institutions; its 2011 health care institutions report includes

ninety nonprofi t entities.  ese survey-based studies fi nd similar patterns in investment per-

formance: the nonprofi ts with the largest endowments tended to get higher rates of return,

and they also tended to invest a higher fraction of their portfolio in alternative investments.1

Nonprofits are not subject to the same pressures on investment performance as are, say,

mutual funds or corporations. Customers or shareholders cannot exit after a poor invest-

ment performance by selling their holdings. Karpoff and Rice (1989) examined the fi nancial

performance of fi rms established under the Alaska Native Claims Settlement Act of 1971.

Although these fi rms were for-profi t, the law prohibited their stock from being traded.  eir

study found that these fi rms performed relatively poorly.  is suggests that nonprofi t fi rms,

also absent this pressure, may underperform as investors.2

Other articles have studied the source of nonprofi ts’ endowments as part of the burgeoning

literature on charitable contributions. For example, Ritchie and Eastwood (2006) examined

how the characteristics of the executives of nonprofi ts infl uence the magnitude and composi-

tion of contributions.